You don’t need to be a CFO or accountant to know that a small business requires monthly revenue, profit, and free cash flow to survive. However, profit alone does not ensure whether a business— or its founder — can succeed long-term.
Rather, a founder must learn the fundamental financial metrics and how these elements influence profit to remain successful. These metrics are called key performance indicators (KPIs).
Though relevant KPIs are sure to shift throughout the evolution of your business, there are several financial performance metrics that a founder should monitor from day one.
In this post, we’re taking a closer look at the top financial KPIs that any founder should be monitoring.
The term ‘KPI’ is short for ‘key performance indicator’ or a quantifiable measurement used to evaluate the return on investment (ROI) of a business in a given period of time. A financial KPI refers to measurable values that quantify the success of revenue, profits, business growth, and other accounting and financial-focused metrics.
When properly tracked and understood, financial KPIs provide founders with a concrete snapshot of the state of their company. In other words, KPIs are the most realistic look into company finances, as they’re generally untainted by reason or emotion — they’re simply data metrics that capture the exact standings of each element of the business.
For new businesses with little to no revenue or profit, or shoddy financial record-keeping, it can be difficult to know where to begin evaluating finances. To complicate matters even further, some small businesses need to spend a lot just to lift business off the ground, which can seriously skew finances.
If your small business is still in its infancy, KPIs like new activations or registrations can help evaluate the potential of your organization to address your customers’ needs. As your business evolves, financial KPIs like overhead costs, customer acquisition cost (CAC), burn rate, and customer churn rate can paint a more accurate picture of your current finances and your potential to succeed. Your finances must be indicative of consumer interest and the ability to turn a profit.
Depending on the type of business you run, you may want to track a few to all of these KPIs.
Revenue is defined as the total amount of money earned from the products and services sold. The simplest way to measure revenue is by multiplying the number of units sold by the average price per unit.
This is a metric that every single founder should keep an eye on.
However, as a financial KPI, founders can gain more insight by categorizing revenue by type, such as recurring vs. non-recurring, and by revenue source.
Revenue = Number of units sold x Average price per unit
Recurring revenue is money a business can expect per month, such as subscription-based purchases, whereas non-recurring revenue consists of one-off purchases, such as a one-time apparel purchase. Revenue source refers to which product or services generated a certain amount — this insight can help founders put more resources towards the products or services generating the most sales per month.
This is another KPI that every single founder should be tracking. Operating costs refer to a small business’s fixed expenses, meaning fees or costs that the business incurs regardless of customers and sales. Common examples of overhead expenses are property taxes or rent for physical office or warehouse spaces, as well as accounting or legal expenses and marketing and advertising costs.
Overhead expenses relative to revenue help define the overall capital efficiency of the company. For a broad example, a startup that generates $1 million in revenue with $150,000 in overhead is technically twice as efficient as a startup that generates $1 million in revenue with $300,000 in overhead. Decreasing overhead expenses where possible can help with overall efficiency.
Just like revenue and operating costs, profit is another KPI that all founders should track. Profit is defined as a business’s total revenue minus its total expenses. In this case, expenses refer to the above overhead costs as well as operating expenses (OPEX). Operating expenses include the costs of labor, materials, and machinery necessary to make the product or deliver a service.
The three major types of profit to monitor are gross profit, operating profit, and net profit.
Gross Profit = Total revenue - Cost of goods sold
Gross profit is calculated by subtracting the cost of goods sold (COGS) from the total revenue. If you’re unsure of your COGS, look at the second line of your most recent income statement. For instance, Company A with $100,000 in sales and a COGS of $40,000 has a gross profit of $60,000. To find the gross profit margin, divide the gross profit by total revenue ($60,000/$100,000 or 60%).
Operating Profit = Gross profit - Operating expenses
Operating profit is calculated by subtracting the operating expenses from the gross profit. If Company A had $15,000 in operating expenses, their operating profit would be $60,000 minus $15,000, or $45,000.
Net Profit = Operating profit - Taxes and interest
Net profit is the income that remains once a startup has paid all expenses, including taxes and interest on its goods sold. It is calculated by subtracting both taxes and interest from the above operating profit. Continuing with the same example, if Company A had $5,000 in interest and $5,000 in taxes, $10,000 would be deducted from their $45,000 operating profit for a net profit of $35,000.
Cash flow refers to the total amount of money that moves in and out of a business over a set period, such as one month or one quarter. Similar to measuring profit, cash flow is forecasted by deducting the total expenses (operating and overhead) from current revenue and potential income. Money received by the business is called inflows and money spent is called outflows.
Cash Flow Forecast = Beginning cash + Projected inflows – Projected outflows
Positive cash flow, also referred to as free cash flow, means you have more inflows than outflows and are making more than you are spending.
Negative cash flow means your expenses or outflows are more than your inflows and you’re spending more than you’re making. To determine your cash flow forecast, add your beginning cash and projected inflows and subtract projected outflows.
Average revenue per user (ARPU) is a principal financial metric for startups that describes the total amount of revenue a business can expect from each customer per month. This metric is particularly helpful for SaaS startups and subscription businesses.
Pro Tip: This metric is similar to — but not identical to — average revenue per account (ARPA). Average revenue per account (ARPA) refers to the average amount of revenue a startup will earn from each paid account.
Depending on a company’s business model, one account can have multiple users. For instance, the popular chat platform Slack has a tiered per-user pricing model where the company earns $8 per month per user on the standard paid plan.
Now, imagine if Company B signed up for the standard paid plan with 10 users. The average revenue per account (ARPA) from Startup B is $80 per month. However, the average revenue per user (ARPU) is just $8. This makes the ARPA and ARPU significantly different — and for a company as large as Slack, that difference is important. Founders should be minding this difference, too.
As the name might suggest, customer acquisition cost (CAC) is defined as the average amount of money spent to acquire one new customer. CAC is typically split amongst sales, marketing, and other related expenses meant to target and attain a new customer, so this financial KPI often speaks to the efficiency of your marketing efforts.
Customer Acquisition Cost = Sum of all sales & marketing expenses / Number of new customers
However, there’s more to CAC than just marketing — for instance, if you spend too much on your marketing at once, you risk negative cash flow for your business. If you spend too little, you may not have enough new customers to remain profitable. For this reason, CAC often goes hand-in-hand with other financial KPIs, particularly customer lifetime value (LTV).
Customer lifetime value (LTV) is a crucial financial KPI for any small business that depends on recurring subscription revenue or repeat customers.
LTV refers to the average amount of revenue expected from one customer over the course of their relationship with your company. It takes into account both monthly inflow and average subscription length for your customers.
LTV = (Average order total x Average number of purchases in one year)(Average length of relationship in years)
Small businesses and startups looking to improve their LTV must increase the average amount of money each customer spends per year and/or ensure customer satisfaction for as long as possible to extend the relationship. By bettering your LTV, you can offset CAC expenses for a truly sustainable company — for instance, a business that can turn a $40 CAC into a $4,000 LTV is highly sustainable.
The opposite of customer retention rate is customer churn, or the percentage of customers lost in a given period. Also referred to as revenue churn or attrition, churn is often the result of customers canceling their accounts or stopping future purchases, thus eliminating revenue. However, churn can also be the result of a customer downgrading their account, reducing future revenue.
Customer Churn Rate = (Number of lost customers at the end of a period / Total number of customers at the beginning of the period) x 100
For example’s sake, imagine Company C had 1,000 total customers at the start of the first quarter and completely lost 50 by the end of the quarter. The churn rate for Company C would be 5%.
CRR = (50/1000) x 100
CRR = .05 x 100
CRR = 5%
In sum, by monitoring these 8 financial KPIs, founders can boost the longevity and profitability of their business long-term.